Wednesday, November 24, 2010

Pieces of paper for stuff a formula for prosperity?

In a recent Econ Talk podcast, host Russ Roberts and then later Don Boudreaux both explain how trade deficits are not worrisome, that globally there must be a net balance in trade surpluses and deficits, and that anyway, giving away paper to get stuff doesn't seem like such a bad deal. Boudreaux's take is more sober, as he specifies that when the paper exchanged for goods goes bad (the currency loses value, the debt is defaulted on, the market value of the company for which the equity represents plummets, etc), things really work out well for the one running the deficit, whereas the assets exchanged appreciating rapidly in value is not so rosy for the country running the deficit. Roberts, in contrast, seems stuck on pieces of paper for stuff is a great deal!

My method for thinking about economic issues is surely risible in the eyes of professional economists who understand economics infinitely better than I do, but as a simpleton, I'm stuck with my method. That method is to analogize whatever is in question to myself at the individual level. Attempting to stimulate the economy through massive spending after people have lost trillions in wealth therefore strikes me as absurd, just as going on a shopping binge after losing my job would be.

Similarly, applying for and maxing out every credit card I can get my hands on seems like a disastrously profligate idea. But like the US running a trade deficit with China, if all I have to do is swipe these pieces of plastic--don't even have to give away paper!--in return for food to eat, stuff at Home Depot to improve my house, and all kinds of other things to play with, joke is on the fools who are giving up valuable stuff for nothing but the opportunity to hold my credit card for a few seconds! Doubly so when I am unable (or refuse) to pay what they say I owe and declare bankruptcy to get them off my back.

I'm sure there is a trade-deficits-don't-matter answer ready for deployment in response to this, but I never hear it from economists like Roberts or Boudreaux. They might respond that the flip side of a trade deficit is a capital surplus, but that works in the credit card analogy as well--whatever I'm buying (or at least many of the things I buy) are capital goods, obvious cases being the purchase of a car or materials to build a fence on my property. Thus I'm enjoying my own capital surplus while I run up my trade deficit.

So is going into credit card debt as long as banks will keep issuing you credit a good idea? Is running a net trade deficit year after year a similarly good idea? If the answer in the case of the former is "no" but in the latter is "yes", why? Simpletons want to know.

12 comments:

Anonymous
said...

I remember as a teen thinking that the guy who buys everything on credit and collects no assets, then goes bankrupt when he loses his job, actually comes out ahead as he gets to eat out at restaurants, buy new fashions and all manner of consumer goods, etc. The poor suckers who provide goods and services but don't collect are the real losers.

Of course nowadays it is the credit card companies who write it off as a loss and post lower profits and pay less taxes, effectively passing the default on to the rest of us who will pay more in tax to make it up.

The whole problem with the scam mentality is that it only works when most folks play by the rules and are genuinely productive. Not everyone can just run scams. Somebody has to actually produce the goods and services. Plenty of idiots think that cheap immigrant labor, both skilled and unskilled is the answer because they haven't yet learned the scam mentality. I am skeptical.

The "trade deficits do not matter" crowd need to reconcile their thinking with several topics:

- If the USD eventually plummets as a result of trade deficits when how are we then going to be able to afford things like oil which we must import?

- If we do not default how do we avoid lower living standards as our interest payments to other countries soar? Some countries like Greece and Ireland are stuck making very high interest payments to foreign creditors.

Hey. I am happy I've found this page, I've been trying to remember the web address. Anyway I would just like to thank you for your time and the posting, I've enjoyed it. I have saved as a favorite it and also subscribed to the RSS feeds.

If you're sick and you know you'll be dead in six months, running up credit card debt and living beyond your means makes sense. Likewise if you're a politician and you'll be out of office in a few years anyway. It's sort of like a reverse mortgage.

The difference between an individual and a government is that the government's creditors cannot force foreclosure and collection. At least not without a war and occupation. At present, China cannot win a war against the US and could not seize our Pacific islands and Alaska. Of course, that might not always be the case.

Boudreaux basicly argues that national trade deficits don't matter (a lot), because trade is never balanced. Trade can only be balanced on a worldwide scale. This argument is sound AFAICT.

Boudreaux also makes a distinction between trade deficits and debts.

Debts often occur because governments either spend more without raising taxes or spend equally, but lower taxes – Bush II and Reagan being two famous examples of the latter. Trade deficits are not similar to debts, because deficits do not create an obligation to pay anything back. Foreigners believe, for wide varying reasons, that they will end up better-off in the long run by sending their goods and services to the US – the result is a net inflow of capital into the US. As Boudreaux says, foreigners (China and its labourers mainly) carry the costs of the trade deficits, Americans do not. After, it’s their products and services Americans can consume and enjoy for comparatively low prices.

Furthermore, Boudreaux explains that trade deficits are not the bugaboo many make it out to be. On his website cafehayek.com he gives the example of IKEA. “In addition, Americans who supply the land and labor Ikea employs to build this store can use their proceeds to start their own firms or to invest in existing American businesses. To the extent that they do so, not only are both America’s trade deficit and capital stock thereby increased, but whatever decision-making ‘power’ Ikea gains in the U.S. by opening a store here is offset by the additional decision-making ‘power’ and prosperity Americans gain because Ikea’s operations in the U.S. enabled these Americans to make investments that would otherwise have not been undertaken.” If Ikea hadn’t come to the US, it wouldn’t have sold furniture or created jobs. The Ikea-induced trade deficit wouldn’t have existed either, but what’s to prefer?

“So is going into credit card debt as long as banks will keep issuing you credit a good idea?”

As long as the bank (Chinese/Ikea) believes that you (US) will be credit worthy (economy) and make money of you (growth, entrepreneurial strength, innovation), yes. The bank (Chinese/Ikea) will even subsidize (investing in the US) your credit (economy) so you could actually make more money (bigger economy), than they’d even be likely to do so. The credit card example probably gives another intuitive reaction, because we associate hugely indebted credit card holders with spend thrifty losers. I’d be more than willing to extend credit to George Soros, Jim Rogers, Warren Buffet and Apple.

PS Something's wrong with blogger. My post disappeared three times before posting.

Sticking to the analogy, I'm not sure how a deficit is not essentially debt. In the credit card example, I'm not really in debt because I have newly acquired assets that, at least at purchase, negate the value of the (credit-granted) dollars I'm giving up. The trade deficit manifests itself in either real dollars, IOUs (treasuries, bonds, etc), or claim of ownership (equity).

Stock isn't debt, but the assets that stock represents aren't really in the US' possession--it's not like the creditor is getting a stake in my paycheck, but instead a stake in the company that pays me, and at some point in the future he has the ability to do whatever he'd like to with that company--move it somewhere else, merge it, hollow it out, fire me from it, etc.

Re: blogger, it does that sometimes, usually in the evenings. Best to ctrl+a, ctrl+c before you attempt to publish.

A trade deficit implies capital inflow. Foreigners will own an increasing amount of US assets (not necessarily good or bad).

Government debts are caused by too much spending or a lack of saving.

A debt has to be paid back (and costs a lot of money too: interest). A trade difference does not have to be paid back. In fact, foreigners believe their capital investment will lead to profits. The fear that high capital inflows into promising US companies -- which is the biggest inflow -- would implicate a loss of control of US companies doesn't scare me that much. Foreigners want to make money, not political control. What could they even accomplish with owning 80% ownership of Apple? Take the example of outsourcing. They could outsource everything to their own country, but will ruin their investment by doing so (countless knowledge will be lost); if they'd outsource low-end manufacturing, that would have happened under US control also (thus doesn't matter either).

One could argue that trade deficits and spending on credit combined indicate a problem. This is clearly the case in the Anglo-Saxon world and means that while households borrow a lot to spend on consuming, there are no counter-balancing forces to create wealth.

Indeed, many fear that because the US has outsourced a large part of its manufacturing base, debts will sky-rocket. This view is wrong.

1) The US manufacturing has grown since outsourcing began, because of automatization and efficiency, hence higher productivity with a smaller work force. See here: http://www.federalreserve.gov/releases/g17/ipdisk/ip_sa.txt2) A succesful economy is likely to outsource/replace/find low-skilled immigrants for its low-end jobs, because living standards rise (You don't need ~90% workers in agriculture or industry to have enough carrots and radios). The US has outgrown its industrial phase and is now in its services centered phase. As Boudreaux and Roberts argue there are also services, like education and others, that are hard to measure in trade terms quantity. Car imports vs. exports are much easier too measure.

The US economy is in trouble, but that's mainly because your government spends too much money it doesn't have, taxes its citizens to make up for it and tries to have the Federal Reserve inflate their debts away. By doing so, they're making the US poorer, because savings are worth less; it also makes the benefits of US economic growth go up into smoke.

As a lawyer for 25 yrs., let me describe a type of case that has never appeared in any bankruptcy court, not once, ever. That is the case in which all of the credit card purchases by the debtor, who is now seeking discharge of his or her debts, were for essentials, such as food, utilties, and the most basic transportation, say monthly bus passes. Since 2005, it is much harder to fully discharge credit card debts, but the cases always involve needless luxuries. I'd like to see someone do it pure.